The marginal rate of substitution (MRS) is one of the most important concepts in economics. MRS indicates the level of replacement between two goods that can be accepted by a person, while their satisfaction or subjective value remains constant. This is important because it provides information about a person’s preference for certain goods, which can be used to determine the price of related goods.
This article aims to provide an understanding of the MRS concept and how it can be used in economic analysis. I’ll start by explaining the definition of MRS and explaining how it is calculated. Then, I will give examples of MRS applications in everyday life and analyze how MRS is considered in economic theory.
Definition of Marginal Rate of Substitution (MRS)
As previously mentioned, the MRS is the rate of replacement between two goods that a person can accept, while their satisfaction or subjective value remains constant. This can be calculated by dividing the change in the amount of one item by the change in the amount of another item received by a person.
For example, if a person has a choice between eating apples and bananas, the MRS for apples and bananas is how many apples must be subtracted to add one banana. If the person had to subtract two apples to add one banana, the MRS for both the apples and the banana would be 2. This means that the person is more satisfied with two apples than one banana.
MRS reflects a person’s preference for certain goods. If the MRS for two particular goods is high, it means that a person is more satisfied with a larger amount of one of the goods than a smaller amount of the other. Conversely, if the MRS for two particular goods is low, it means that a person is more satisfied with a smaller amount of one of the goods than a larger amount of the other.
MRS Analysis in Economic Theory
In economic theory, MRS plays an important role in the analysis of purchasing and production decisions. In consumer theory, MRS is used to determine whether someone will buy more or less of an item depending on the price of that good and the prices of other goods available. If the MRS for two particular goods is high, then a person will be more likely to buy more of one item and less of the other. Conversely, if the MRS is low, a person will be more likely to buy less of one item and more of the other.
In production theory, MRS is used to determine whether a person will spend more or less resources to produce an item depending on the level of profit expected from the production of that good and the level of profit expected from the production of other goods. If the MRS for two particular goods is high, then a person will be more likely to spend more resources producing one of the goods and less on the other. Conversely, if the MRS is low, a person will be more likely to spend less on producing one good and more on the other.
Actually the concept of Marginal rate of substitution is a derivative of marginal utility theory. So before understanding the matter of the Marginal rate of substitution we should first understand the theory of marginal utility.
Let’s talk about the theory of marginal utility first. So in this theory, it is discussed that consumer satisfaction will decrease when consuming the same item continuously. For example, if we are thirsty, then when we drink a glass of water, we will get the greatest utility value. But then in the second glass and the third glass the level of utility will decrease, while the marginal utility will increase. The point is that there will be a point where drinking another glass of water instead of quenching thirst, will actually make you feel nauseous, hehehe. Let’s say we can only accept 3 glasses of water and we are not interested in drinking the fourth glass of water.
Now in the Marginal rate of substitution we talk about at what point do consumers want to exchange the fulfillment of these utilities for other goods. In the example above, for example, we combine a glass of water with orange juice. So maybe a glass of water and a glass of orange juice is enough to get the maximum level of satisfaction or level of utility. So the Marginal rate of substitution in the case of plain water is one glass, and maximum satisfaction will be obtained simply by adding a glass of orange juice compared to 2 glasses of plain water. After drinking 1 glass of water and 1 glass of orange juice, the maximum amount of satisfaction you get and thirst can be quenched.
Example of Marginal Rate of Substitution (MRS) Application
MRS can be used in a variety of situations in everyday life. For example, if a person has a choice between working more hours to earn more money or working fewer hours to have more free time, the MRS for money and free time is how many hours one has to work to earn one hour of free time. If the person has to work four hours more to earn one hour of free time, then the MRS for money and free time is 4. This means that the person is more satisfied with four hours of work than one hour of free time.
MRS can also be used to determine the price of related goods. For example, if the price of oil rises, the price of goods that use oil as a raw material will also increase. However, if the prices of other goods that can be used as substitutes for oil also increase, then the MRS for oil and its substitutes will decrease, meaning that a person may be more inclined to purchase less oil and increase purchases of substitutes.
